Tuesday, December 22, 2015

When it comes to having good credit, you already know how important it is to pay your bills on time. But how you pay your bills -- not just whether you pay them -- is becoming increasingly important.

In the past two to three years, all three major credit bureaus have added a treasure-trove of new data to their credit reports. Analysts are slicing and dicing "trended data" in hundreds of ways, but probably the biggest change is that lenders now know exactly how you pay your bills: whether you're a high-risk "revolver" who carries a balance, or a low-risk "transactor" who pays your credit cards in full every month.

Research shows that information is an important predictor of risk. Revolvers are three times more likely to default on new credit cards and auto loans and five times more likely to default on current credit cards than transactors, a TransUnion study found. Partial payers -- those who actively pay down their balances -- are a lower risk than those who just make the minimum payment.

But that's not the only way the credit industry is using the new data. They also analyze:

What kind of spender you are.

How your credit behavior is changing over time (are you trending up or down?).

How often you open and close accounts.

What you spend every month -- and more.

Then, they're pairing that information with data from other sources, such as property and employment records, to create new models that can predict everything from your interest in a rewards card to your likelihood of default on different types of loans.

"In the credit industry, this new data is a game-changer," says credit expert John Ulzheimer, who has worked for credit scorer FICO and credit bureau Equifax. "For lenders, it tells a much richer story about your relationship with your credit cards than what has traditionally been on your credit report. For consumers, it means how you manage your credit card accounts may determine whether you get a loan and what terms you'll get."

Trends in your payment history
Until recently, your credit report displayed a snapshot of your accounts at a single point in time: your monthly balance, your credit limit and whether you failed to make at least the minimum payment.

Now, credit reports from all three bureaus show two years of payment history, so lenders can see exactly what you paid on each account each month and whether you tend to carry a balance, pay more than the minimum or pay off your card in full.

In addition to telling them how you pay your bills, seeing your payment behavior over time gives lenders a more comprehensive understanding of your financial situation.

"This is very powerful information for us," says Paul DeSaulniers, senior director for risk scoring and trended data solutions at Experian. "Now, we can see what the trend is: Are you gathering debt or paying down debt?"

For now, the new information is not part of the calculation used to create your traditional credit score from FICO or its biggest rival, VantageScore, although industry observers say both companies are likely examining whether to incorporate it. But mortgage-finance company Fannie Mae announced in November that it will require lenders to use the data in loan decisions beginning in mid-2016. Because Fannie Mae backs the majority of all new residential mortgages in the U.S., that change is expected to have a sweeping effect on the mortgage market.

The new data may help potential buyers who have a short-term blip on their credit that's pulling their score down, says Alex Johnson, senior analyst at Mercator Advisory Service.

"Let's say you have a credit score of 690, and that's right around the lender's cutoff," he says. "If you lost your job during the recession and your score went down, the bank can see that your behavior over last 18 months has really improved and has been very strong from a credit risk perspective. So they may be more lenient in making the loan."

On the other hand, if you have a 730 FICO score that would normally be well within the bank's risk criteria, you may be declined if the bank spots a downward trend in your payment behavior.

New trended data products
The credit bureaus are using their trended data to create new products they can sell to lenders that better analyze consumer risk. Experian sells a trended data product called Trended Solutions, Equifax offers something called Dimension, and TransUnion has a product called CreditVision.

"We've taken all of that raw data and drove it into actionable results for our clients," says DeSaulniers of Experian. "We offer well over 50 products and 500 trended attributes."

In their marketing, the bureaus tout the ways they can categorize potential borrowers beyond just transactors and revolvers. They are also combining trended data with alternative data sources such as checking/debit account information, property and tax records, rent and utility payments and payday loan information to make it easier for lenders to evaluate people who don't have a credit history.

TransUnion has used the combined data to create a new score for customers called CreditVision Link, says Mike Mondelli, senior vice president of Alternative Data Services at TransUnion. Mondelli says the new model allows TransUnion to score 95 percent of the U.S. population, including 60 million consumers who were unscorable using traditional methods.

How trended data is used
Here are some other ways financial institutions are analyzing and using the new data:

Whether you are adding debt or paying it off. Take two consumers who both have $10,000 in debt. On the old report, they would look exactly the same, even if one had $20,000 in debt two years ago and the other had only $3,000. "So one person recently added $8,000 in debt and the other has recently paid off $20,000," DeSaulniers says. "They are very different from a risk perspective."

How you handle a higher utilization rate. Under the traditional model, if your utilization rate (the sum of your balances divided by your credit limit) is high, you are considered higher risk. But if a lender looks at two years of data and sees that you've consistently had a 40 or 50 percent utilization rate with no ill effects, "That's a consumer I want to do business with," DeSaulniers says. "Even though they have a high utilization rate and their credit score may lower, I know they have been able to manage it over time."

Changes in your payment patterns. If you suddenly start paying just the minimum payment on one account you used to pay in full, that may be a sign that you're about to default on other accounts. Even if you're still making your normal payment, lenders looking at the data may reach out to you to make sure they remain a top priority.

How much you spend each month. Having access to the raw dollar amounts you pay every month helps lenders identify the high-dollar transactors who are going to rack up swipe fees for credit card companies. It also gives lenders a better idea of your discretionary income, Mondelli says. "If someone can make a payment of a couple thousand dollars to their credit card on monthly basis and they do that consistently, that gives you some insight into what their income might be and their ability to pay for new credit products," he says.

The bureaus say there are hundreds of other ways they are analyzing the data, but they are reluctant to share too much for competitive reasons. The new, deeper level of analysis can be good news for consumers who are on an upward trend, who have shied away from traditional credit products but now need credit, or who pay off their credit cards every month.

But it's going to cut both ways. "You will have people who will benefit from this and people who won't benefit from this," Ulzheimer says. "The revolvers who pay some portion of their bill on time every month will be frustrated that they don't benefit. In their minds, they're a good credit risk because they're not delinquent on their bill. But it won't matter."

We call this our “curveball” account. It’s an emergency fund for use when life throws us curveballs — large medical bills, a job loss or reduction in income, major home repairs, that kind of thing.

3. Make a plan for big-ticket items.

My husband and I agreed that we would use one family credit card for large purchases, such as airline tickets and hotel stays. We still have our separate credit cards — it’s wise to keep your own credit cards to maintain your credit score and credit history. Using them once or twice a year should be sufficient. And don’t close those cards because it will affect your overall credit score.

Implementing the system

1. Draw up a budget for fixed and variable expenses.

Add up how much you need in each category. This will be your guideline for how much should be in each of your checking accounts.

When your paycheck comes in, allocate the designated amounts into each checking account based on the budget you created. The sum earmarked for the curveball account can go there directly.

3. Pay fixed costs directly.

All bills are paid automatically from our fixed-expenses account. We do not have to write any checks, and no debit card is necessary. This account has a cushion of a few hundred extra dollars in case a bill shows up unexpectedly or before we have a chance to replenish the account.

4. Pay variable expenses from the second account.

This account should have a debit card, which you can use for purchases.

If an emergency arises, you can transfer funds within 24 to 48 hours. You can then access the money with a check or debit card.

Realizing the benefits

Once I implemented this system, the process of tracking expenses wasn’t so cumbersome anymore. Separating expenses into fixed and variable categories meant I didn’t have to worry constantly about checking account balances. Having fewer transactions in each account also made it easier to see the bigger picture of our spending.

Every family’s finances are different, of course. Feel free to customize my system as necessary. The point is to get — and keep — a grasp on the flow of your money. If you know exactly what’s coming in and going out, you can’t be surprised by debt.